Parametric insurance is a relatively new concept that’s getting increased attention as a way to provide faster and more flexible funds to victims of disasters. Most of the US citizens and corporates are familiar with insurance that reimburses them for damages they sustain or the cost they incur after a specific event. For example, when there is a house fire, insurance will pay the cost of fixing the damage. For these insurance policies, the insurance company must know the exact cost or loss in order to restore the asset to its pre damaged state. In our industry, this is referred to as indemnity insurance.
In contrast with parametric insurance, the amount of the payout is dictated by the objective measure or causal event instead of the damage that’s been sustained. Parametric insurance comes from the word parameter, so it’s the parameters around a causal event that triggers a policy. For example, the power could be related to wind speed as it connects to a cyclone parametric cover, or it could be a large earthquake that is triggered by an event meeting a predefined seismic threshold. Once a policy is triggered, then a lump sum is paid right away.
Types of Parametric Insurance
The history of parametric insurance goes back to the 1990s with the development of agricultural insurances designed to assist farmers in developing countries to better manage exposures to weather-related risks. The concept gained further traction with the development of the Caribbean Catastrophe Risk Insurance Facility, which was established in 2007 and was a parametric insurance structure that responded to weather catastrophes. The Pacific Catastrophe Risk Insurance Company was established in 2016 and provides parametric insurance for the governments of the Pacific Island countries. More recently, in 2021, parametric microinsurance gained traction in the Pacific Island and climate adaptation program in Fiji. This was launched with the objective of building financial resilience to natural catastrophe risks in the Pacific Islands.
Parametric insurance has historically been used to cover large commercial risks and provide sovereign insurance to governments using large regional risk pools. But it’s also used to provide microinsurance solutions to victims of disasters in developing countries. More recently, it’s also used to provide customers in the developed world with extended covers. Examples include Flood Flash, which provides parametric flood insurance in the UK, and Jumpstart, which provides parametric earthquake insurance in California.
Benefits of Parametric Insurance:
There are three key benefits of parametric insurance. Firstly, it helps close a catastrophe protection gap by providing affordable cover on a standalone basis or by providing protection for losses and out-of-pocket expenses that are not typically covered by traditional insurance. Coverage can extend to liabilities relating to large excess deductibles or lengthy deferment periods on business interruption policies, or it could simply apply to lifestyle and personal expenses that would not typically be covered by traditional policies.
Secondly is the speed of payment. Payouts for traditional indemnity-based insurance cannot occur until the conclusion of often lengthy SSA and loss adjustment processes. Since parametric insurance instead pays out based on an observed and independently measured event, payment can be made extremely quickly and often within days.
Finally, parametric insurance policy wording is substantially simpler than traditional indemnity insurance contracts. Rather than having pages of requirements, exclusions, and complex wording, parametric insurance policies focus on the type of event and the parameter conditions that enable a policy to respond. This makes parametric policies easier to understand from a customer perspective.
Types of Parametric Insurance
Parametric insurance provides faster and more flexible responses to victims of natural disasters by providing an upfront cash payment. It has a track record of supporting communities and countries around the world for over two decades. Finally, it helps close the protection gaps around natural disaster risks.
Parametric insurance comes in several types depending on the risk trigger (the measurable event) and the industry it serves.
1. Weather-Related Parametric Insurance
Triggered by measurable weather events such as wind speed, rainfall, or temperature.
- Hurricane / Cyclone Insurance: Payout based on sustained wind speed or storm category.
- Drought Insurance: Triggered by below threshold rainfall over a set period.
- Excess Rainfall Insurance: Activated if rainfall exceeds a certain limit.
- Temperature Insurance: For agriculture, events, or businesses affected by extreme heat/cold.
2. Natural Catastrophe (NatCat) Parametric Insurance
Covers large-scale disasters with clearly measurable triggers.
- Earthquake Insurance: Triggered by magnitude (e.g., 6.5+) and location data from seismic networks.
- Tsunami Insurance: Triggered by wave height readings from ocean buoys.
- Flood Insurance: Based on water levels recorded by gauges or satellites.
- Wildfire Insurance: Triggered by official fire perimeter maps or heat index data.
3. Agriculture Parametric Insurance
Helps farmers manage crop loss risks.
- Yield Index Insurance: Triggered by regional average yields dropping below a set threshold.
- Vegetation Index Insurance: Based on satellite-measured vegetation health (NDVI).
- Livestock Index Insurance: Triggered by pasture conditions or temperature impacting feed availability.
4. Pandemic & Health Event Parametric Insurance
Payout based on epidemiological data.
- Pandemic Business Interruption: Triggered by WHO/CDC case numbers exceeding thresholds.
- Parametric Epidemic Coverage: For event organizers or tourism businesses.
5. Energy & Utility Parametric Insurance
For renewable and traditional energy sectors.
- Solar Irradiance Insurance: Triggered by below-average sunlight impacting power generation.
- Wind Energy Insurance: Triggered by wind speed data for wind farms.
- Hydropower Insurance: Based on reservoir water levels or rainfall amounts.
6. Travel & Event Parametric Insurance
Quick payouts when travel or events are disrupted.
- Flight Delay/Cancellation Insurance: Triggered by official flight status data.
- Event Weather Insurance: Triggered by temperature, wind, or rain data during the event period.
7. Cyber & Technology Parametric Insurance
Triggered by predefined data or outage metrics.
- Cyber Outage Insurance: Based on downtime duration detected by monitoring services.
- Cloud Service Disruption: Triggered by uptime SLA breaches from service providers.
8. Financial & Market Risk Parametric Insurance
Covers volatility and market-specific risks.
- Commodity Price Index Coverage: Triggered by market prices crossing set limits.
- Currency Exchange Volatility Insurance: Based on exchange rate swings.